Do You Smell Smoke in Tobacco Stocks?

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Feb 17, 2012
Yield chasing has pushed tobacco stocks’ valuations to their multiyear highs, while the dividend yields from the stocks are at multiyear lows. While income investors do not have a lot of options left by the historical low bond yields, they may want to watch out. Don’t forget Warren Buffett’s rule number one while the party is going on nicely. Tobacco stocks have been very rewarding to investors. They are less volatile, and they generate far fatter dividends than bonds. But investors need to be aware that the dividend yield of tobacco stocks are at decade lows, while their valuations are at decade highs. Historically, valuations tend to reverse to their means.


The decade low yield of tobacco stocks can be clearly seen from our new interactive charts, which are embedded below. The chart shows the dividend yield of three tobacco stocks: Reynolds American (RAI, Financial), Philip Morris International (PM, Financial) and British American Tobacco (BTI, Financial).


BTI,RAI,PM yield Interactive Chart




In 2003, when the tobacco industry was threatened by another large litigation risk, the dividend yield of Reynolds American (RAI) was at 13%. In the market crash of 2008-2009, the yield was more than 10%. Today it is at a little above 5%. While 5% is high compared with the market average, only in 2005-2007 the yield was lower than its current value. We know what happened after 2007, the stock declined more than 30% in from 2008 to the first quarter of 2009.


The situation is even worse with Philip Morris International (PM) and British American Tobacco (BTI). The yields for both of them are at their historical lows.


Owning tobacco stocks has certainly been rewarding to investors. Besides generating nice dividends, the stock prices have also outperformed the market significantly since the last market peak in 2007. While the S&P500 is still below its peak, tobacco stocks have made new highs. See the price chart below for Reynolds American (RAI), Philip Morris International (PM) and British American Tobacco (BTI).


BTI,RAI,PM Interactive Chart




While everything has gone well, the valuations are at their highest level. See the historical P/E of these three companies below:


BTI,RAI,PM pe Interactive Chart




A historical high valuation is usually followed by a reversion to the mean.